Throughout my history in the insurance business, there have been cycles,
formerly 3 years in duration, where rates hardened, profits were made, and
then competition reduced rates and underwriting standards to live off the
interest of increased cash flow. This was known as cash flow
underwriting—get the money in the door. I recall one A-rated insurer that
filed a 100 percent rate deviation in Illinois. Giving it away to get cash?
Uh, what cash?

And, of course, the losses would drive the rates back up, and we would
start all over again.

Macro Indicators of a Hardening Market

No one, including me, is predicting another hard market or return to
cyclical underwriting. The world is far too complicated, global, and fast
for that to happen. However, allow me to point to some items that, on the
surface, may mean little but, in a macro view, may indicate that we're
heading toward higher prices.

Some liability lines are seeing both hardening rates and even withdrawal
from the market by underwriters who do not wish to play in a low-return
game. This is particularly true for truckers—perhaps not everywhere, but I
have seen several examples of this movement.

Workers compensation is clearly showing signs of upward revisions. This
also is not nationwide but is increasing in size, number of Securities and
Exchange Commission codes, and locales every month. Seeing a shortage of
underwriters may not be far off. Increasing medical costs, as usual, and
increased claim filings attributed by many to the economy are driving the
pressure on rates. (I can't get work, but I hurt my back at my last job, so
I will file a claim.)

There is an anecdotal increase in cases of the Internal Revenue Service
(IRS) going after audit preparers for giving bad advice on captive
formations and related wealth-management products. How is this related?
Well, aside from being an enforcement of the law, it is also clearly a new
source of untapped revenue for the Feds. This also applies to captive
managers. Can increased professional liability premiums be far behind?
Increased costs for the captive?

On another front, there is a noticeable increase in states forcing the
reclassification of independent contractors as employees. How does this
relate? It is another new source of untapped revenue, as the employer will
owe back taxes and of course union dues, insurance premiums, and claims
under workers compensation.

As I speak to clients, prospects, and colleagues, we have not previously
learned of so many instances of the IRS field auditors asking about captives
as the first topic. The word has gone out: "Find those captives and check
them very closely for compliance!"

There are now more tax rules than ever, and tax advisers must keep up. No
longer does the IRS consider a captive's CPA to be the uncompromising source
for expertise.

How many reinsurers of captives hold Greek, Portuguese, Italian, or Irish
debt? At a minimum, they hold investments of funds that hold these under
water bonds.

None of this is necessarily related, and the law must be enforced without
question. My view is that now that money is global and information of all
types can be traded instantly, the old ways of thinking are going away.
Anybody can track down your activity. We truly live in a time when a camel
sneezing in Saudi Arabia can influence your renewal.

In the past, captives were generally anonymous and private. Often,
regulators forgot or ignored them. No more. They are solidly in place as
revenue producers for state and domicile regulators and now for the tax man.

This will not cause a slowdown in formations, but I caution that it must
force the captive owner to be certain that he or she is getting good advice
and holding the practitioners to high standards. I always advocate care and
caution, and the aforementioned matters reinforce the need to deal with
professionals and to learn about what the captive responsibilities and
opportunities mean to you. Know your captive!

Conclusion

For those enjoying the "soft" market, now is the exact time to plan ahead
for a captive formation. A few more months, and the scene could change—and
not favorably for the new owner.

Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

Like This Article?

IRMI Update

Dive into thought-provoking industry commentary every other week,
including links to free articles from industry experts. Discover practical
risk management tips, insight on important case law and be the first to
receive important news regarding IRMI products and events.